(photo credit: MARC ISRAEL SELLEM/THE JERUSALEM POST)
Finance Minister Moshe Kahlon and Bank of Israel governor Karnit Flug recently launched a committee to reform Israel’s banking sector.
Ambition must be matched with action to break up Israel’s harmful banking oligopoly that leaves customers frustrated and small businesses short of credit.
Israel’s banking sector is highly concentrated, meaning that a few firms dominate the market. Five banking groups, namely Leumi, Hapoalim, Discount, Mizrahi-Tefahot and First International Bank, control 94 percent of the market. As a result, Israel’s three largest banks (Leumi, Hapoalim and Discount) control a staggering 90% of commercial loans, almost double the proportion controlled by the three biggest banks in countries such as the United States, Spain and Italy.
A highly concentrated market where a handful of banks dominate virtually the entire sector leads to highly undesirable consequences for both private banking customers and small firms.
According to the latest Bank of Israel report, in 2012 there were over 20,000 banking-related complaints, with a huge NIS 3.8 million reimbursed to customers due to errors. Complaints ranged from charging customers for letters that were not even sent, to charging currency conversion fees for shekel purchases from Israeli companies! Since customers have few options, banks “rest on their laurels” and are complacent about providing efficient, quality service to their customers.
In Israel, only 3% of customers leave their bank per year compared with the EU average of 8%, and the average Israeli customer stays 23 years with the same bank in contrast to the EU average of under 10 years. With so few alternative providers, Israeli customers have little choice but to stay with their current bank and suffer the poor service that results when firms know their clients have few escape routes.
Perhaps more damagingly for the economy, banking oligopolies make it far harder for small-to-medium sized businesses (SMEs) to obtain the credit they need to run and expand their business. In Israel, SMEs account for 97% of all businesses, 50% of GDP, and 60% of all private-sector employees, yet they receive less than a third of bank-issued credit. Few suppliers of credit leads to a phenomenon known as “credit rationing,” where lenders exclude smaller, riskier businesses, whose comparatively small size puts them at the highest risk of default, at the expense of big businesses that can easily repay.
Overall, this severely harms entrepreneurship and the growth potential of small firms which, as shown above, form a crucial segment of the Israeli economy.
A small number of firms dominating a market creates problems throughout the economy, and the newly launched committee by Kahlon and Flug must act with urgency to increase the number of firms involved in banking. A good start would be to reduce regulatory requirements, as a way to incentivize international banks to compete in Israel’s banking sector. According to The World Bank, Israel has one of the most regulated banking sectors worldwide, with only South Korea being more heavily regulated. The Bank of Israel’s “Proper Conduct of Banking Business Regulations” is one of the toughest regulatory manuals worldwide – covering all areas of banking from mundane daily operational requirements to management structure. International firms balk at the cost of complying with Israel’s regulatory requirements, having to pay for scores of lawyers and administrative staff as an ongoing cost to meet the law in an unfamiliar land.
It is hardly surprising that foreign banks have not made serious inroads into the Israeli economy.
In addition to encouraging new entrants, the government should boost lending to SMEs by offering tax credits to banks that lend to them. In the United States, the federal “New Markets Tax Credit” program set up in 2000, which offers tax credits for various loans, including those aimed at small businesses, has incentivized billions of dollars worth of investment across the US.
The equivalent program in the UK, the “Community Investment Tax Relief,” provides a tax credit of up to 25% for investments in SMEs, and has played an important role in the UK’s recent economic upsurge.
Kahlon and Flug have openly admitted the need to make Israel’s banking sector more competitive, but as each day goes by the risk of the early resolve and enthusiasm fizzling out increases. Cutting regulation to encourage foreign entrants, as well as providing direct incentives to lend to SMEs, can finally give banking customers and small businesses the banking sector they deserve from a world-class economy.
The author is a Research Fellow at The Jerusalem Institute for Market Studies.